My understanding is that you can pause watch history, see link below.
I find it equally odd to assume that they do exactly what they say.
If you stop watch history, that must mean no watch history is collected.
Is your hypothesis that a large company would consider violating important privacy laws for minimal gain (very slightly improved ad tracking)? It's possible but unlikely.
It's not really a hypothesis at this point. I've seen first hand plenty of companies that treat fines and lawsuits as a cost of doing business. If the expected profit is higher than expected fines, full speed ahead. GDPR does have large potential fines, but for all I know the math could still work out.
Not only that, but they have enough information on user locations that it might be worth it to segment it out. Take every jurisdiction a given user might be connected to, use the most restrictive overlap of laws, and track each user as much as legally possible. Most users are not under GDPR or similar, and if you miss one here or there you take it out of the fine budget.
How come? If someone sends me an email to my FOSS server, which I open with my FOSS client, I don't care if the server they used to send me is FOSS or not. If YouTube is just sending me data (not running their code on my machines), why should I care what they run?
In any case, to use YouTube Premium you have to login, and therefore have all your viewings tracked. Being able to have subscriptions, etc while avoiding having to login is one of the great features of NewPipe.